Sundance kid not necessarily a wild bet

Which will correct? The oil and gas stocks, or the oil price?

Will there be a massive capitulation of the global oil markets because they realise that investors in companies such as Beach Energy, Drillsearch Energy, Sundance Energy and Molopo Energy have been right in selling their stock?

Radar thinks a more likely answer is that some of these companies have been sold off too aggressively.

The market for small-cap resources stocks has already staged a mini-fightback this month, but in the past three months the S&P/ASX Small Resources index is still down by about 17 per cent.

A big reason for the market's fear is uncertainty about funding, since mining is a very capital intensive business. Sentiment could also be damaged in the oil and gas sector by the revolution in shale gas and the dark art of fracking.

Because of the massive supply that has come on stream, the price of gas in the US has plummeted in the past two years, from $US13 per million standard cubic feet to almost $US2 per MMSCF.

So far there is limited substitution of oil for gas in the US, but equity markets look forwards and this might change as transport fleets are converted to run on liquefied natural gas.

One company in the middle of all this, and which Radar has mentioned before, is Sundance Energy whose shares, at 43?, have almost halved in the past five or so months.

Sundance has about 50 producing wells located in what analysts describe as the "hot spot" for shale oil and gas production: the Bakken region located primarily in North Dakota. The US Geological Survey estimates the region contains 3.65 billion barrels of oil.

The sell-off appears to be unjustified, first because oil, rather than gas, is Sundance's mainstay. About 75 per cent of its production is oil the remaining 25 per cent is gas, which is "liquids rich", analysts say, enabling Sundance to get a better price for it.

The main reason for Sundance's share price demise is that the market thinks the stock will need to raise equity funds. A quick look at Sundance's financial statements shows that it is running precariously close to the wind, with an operating cash flow of less than $10 million for this year, and capital expenditure and exploration costs in the region of $35 million. It is also due to spend about $75 million this year.

However, Bell Potter's senior energy analyst, Johan Hedstrom, says it is probable that the company will not need to raise cash, partly because of a $100 million debt facility. The company can draw down $25 million of it at this point, but this is based on its oil and gas reserves at June 30, 2011. Those reserves are under review, and should more than double, meaning an increased cash flow that will enable Sundance to draw down more funds.

The main reason for Hedstrom's confidence is that the sale of one of Sundance's Bakken assets, for between $150 million and $200 million, could go ahead as early as next month. .

Richard Hemming edits the fortnightly newsletter undertheradarreport.com.au